Why Is the Death Tax Still Alive? Looking Back at 100-Plus Years of Inheritance Taxation
Next year marks the 100th anniversary of the federal estate tax, also known as the death tax. Although it’s a minor source of revenue for the nation, this tax looms large in the minds of many Americans.
There are two views on leaving wealth behind for one’s heirs: One side wants to let people keep what their forebears earned without being taxed out of a business or farmstead, while the other side sees the tax as social justice.
With estates valued up to $5.43 million for individuals exempt in 2015 ($10.86 million for couples), only about 0.2 percent of estates will be subject to the tax. Granted, the top taxation rate on these estates is a whopping 40 percent. If the tax were abolished, heirs could reinvest those savings in productive enterprises, thereby reducing revenue loss for the government.
In April, the U.S. House of Representatives voted to eliminate the federal death tax, which could set the stage for repeal within the next few years. It’s important to understand this tax’s history, including its purpose during wartime.
The Death Tax’s Lively History
Inheritance taxation goes back to the ancient Egyptians and was widely used in 18th-century Europe, whose death duties were copied in the early days of the American Republic.
In 1797, federal stamps on wills offered for probate helped finance the U.S. Navy’s undeclared war with France, along with stamps on letters of administration, inventories, and receipts and discharges from legacies and interstate property distributions.
This tax was repealed in 1802, but when the Civil War began in 1861, the nation’s principal sources of federal revenue—tariffs and taxes on land exchanges—proved inadequate. Enter the Revenue Act of 1862, which included an inheritance tax on personal property in addition to a stamp tax on the probate of wills and letters of administration. The inheritance tax’s rates were graduated based on the heir’s relationship to the departed, not on the estate’s size or bequest’s value.
Revenue needs increased as the war went on, and the act was amended in 1864 to raise legacy tax rates and add a succession tax on real estate bequests. The nation’s first gift tax, which taxed transfers of real property made during a descendent’s lifetime for less than adequate consideration, was introduced the same year. The end of the Civil War gradually eliminated the need for this extra revenue; the legacy and succession taxes were repealed in 1870, followed by the stamp tax in 1872.
The legacy tax came back in 1898 along with the Spanish-American War, bringing with it some of the same arguments that exist today: the idea of making the wealthy “pay their fair share,” as the IRS puts it, versus the idea that such taxes will discourage people from building and retaining businesses and harm capital-market growth. This tax ended with the war in 1902.
Shaping Current Law: World War I to the 21st Century
The modern version of the death tax was not far away, however. World War I brought fiscal pressures, and 14 years later, Congress passed the Revenue Act of 1916. Under this act, the inheritance tax on beneficiaries was switched to a tax directly levied on the estate. This time, it stuck around after the war ended.
The federal estate tax has been updated over the years, including a gift tax imposed in 1932 and adjusted valuation periods implemented in 1935 to allow for declining estate values. Estate and gift tax marital deductions were introduced in 1948. This remained the status quo until the Tax Reform Act of 1976, which merged the estate tax exclusion and the lifetime gift tax exclusion into a single credit.
The act also included a provision barring intergenerational trusts, or an attempt to pass funds through one’s children to the next generation, so that the money would be taxable to grandchildren but not to direct heirs.
Tax Relief in 1981 and Beyond
In 1981, the Economic Recovery Tax Act gave an unlimited marital deduction to spouses and increased the tax credit available on both gift and estate taxes. The 1997 Taxpayer Relief Act then effectively raised the tax threshold to $1 million and indexed many credits and exemptions for inflation.
Further changes beginning in 2001 gradually increased the exemption amount until, in 2010, it was unlimited for donors who died that year. This exemption was only a temporary stimulus measure, and the estate tax returned to 2001 levels in 2011.
Thanks to exemption increases, the estate tax is not as harmful as it may have been in the past. While it remains very much alive, it appears to be more valuable to its defenders as a symbol of ideological commitment rather than a real benefit to the nation. That’s not a very sound rationale for keeping it on the books for another 100 years.